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Morningstar | ACCC's Unwanted Christmas Present to TPG Telecom

The Australian Competition and Consumer Commission's, or ACCC's, preliminary concerns regarding TPG Telecom's proposed merger with Vodafone Australia does not come as a surprise. The regulator's central tenet is that the deal will ensure the mobile industry remains a three-player market and that a player (Vodafone) will also be eliminated from the fixed-line broadband market. It is a view we have been stressing and is why we have urged investor caution not to assume ACCC clearance, let alone bake in the potential merger synergies--exuberance that is quickly dissipating with TPG shares coming back towards our unchanged AUD 6.10 fair value estimate for the group as a stand-alone entity.

However, investors should not abruptly change sentiment 180-degrees and begin assuming the proposed merger is dead. Granted, the ACCC's concerns are strongly-worded, with the removal of narrow-moat TPG as a price-aggressive new entrant in the telecom market viewed as "likely to result in a substantially lessening of competition." But it is a preliminary view and the final decision (due March 28, 2019) will hinge on feedback and submissions from interested parties in response to the published Statement of Issues.

It goes without saying that TPG and Vodafone will do their utmost to address the competitive concerns. The ACCC will be bombarded with reasons why the merged entity's size, scale and strength will enable it to better invest and compete against incumbents and innovate for the benefit of consumers across all telecom segments (mobile, fixed-line, and corporate). We believe the likes of Telstra, Optus and Vocus are also unlikely to mount much resistance to the merger, given its positive implications on competitive dynamics in the already ultra-competitive mobile and broadband markets. As such, the fate of the TPG-Vodafone tie-up may come down to the force of submissions from consumer interest groups and how resolutely committed the ACCC is to its preliminary concerns.

Prior to today's announcement from the ACCC, the market was not only assuming that the proposed TPG-Vodafone merger will complete, but was baking in significant synergies. If the combined TPG-Vodafone EBITDA of AUD 1.8 billion is capitalised at the current global telecom average EBITDA multiple of 7.5 times, less AUD 4.0 billion in aggregate net debt, we calculate that TPG closing stock price on Dec. 12, 2018 was incorporating over AUD 600 million in synergies from the merger, or 24% of Vodafone's current cost base. It was even higher when TPG stock price had reached up to AUD 9.65 soon after the merger was first announced. As we had stressed at the time, it presented an opportunity for those shareholders wishing to crystallise the gain, with the stock price at a substantial premium to our intrinsic assessment of TPG as a stand-alone entity.

We also previously highlighted the vastly different cultures of TPG and Vodafone. TPG has grown to its current size with a modus operandi premised on an extremely lean cost structure and an entrepreneurial spirit more akin to a private, nimble company. Vodafone on the other hand is a stereotypical, buttoned-down corporate entity with its attendant hierarchy and multi-layered decision-making processes. How these two cultures will gel as a single company will be complicated by the fact that TPG executive chairman David Teoh will likely step back from day-to-day operational involvement. However, this is now a secondary concern for shareholders in light of the ACCC's preliminary view on the merger.